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2016 – a list of lists regarding the macro investment outlook

2016 should end much better than it has started off for investors, ultimately providing ok investment returns, but expect a continued volatile ride.

Watch the Fed, the $US, global business conditions indicators, China and business confidence in Australia.

The investment cycle still favours growth assets over cash and bonds – despite all the volatility.

Introduction

2015 saw subdued returns for diversified investors as the global economy continued to grow and monetary conditions remained easy, but worries about deflation, plunging commodity prices, fears of an emerging market crisis led by China and uncertainty around the Fed’s first interest rate hike after seven years with near zero interest rates along with continued soft growth in Australia, saw volatile and soft returns from share markets. Balanced super funds had returns of around 5%, which was not disastrous given that returns have averaged 10.1% pa over the last three years, but still disappointing. 2016 has started with many of the same fears seen in 2015. This note provides a summary of key insights on the global economic and investment outlook in simple point form.

Four lessons from 2015

Global growth remains fragile and constrained and this is continuing to drive bouts of volatility in investment markets.

Deflation still remains a bigger threat than inflation – this is flowing from the secular plunge in commodity prices but also from slower potential economic growth. It reinforces the view that interest rates will remain low for longer.

Turn down the noise – despite talk of recessions & crashes, returns from a well-diversified mix of assets were still better than cash or bank deposits.

Diversification and active asset allocation are critical – the uneven and volatile return environment (with Australian shares underperforming again) provided a reminder of the benefits of diversification.

Key themes for 2016

Global growth of 3% or just above, with the US around 2%, Europe and Japan lagging and China running around 6.5%, but Brazil and Russia still in recession.

Scope for a cyclical bounce or at least stabilisation in commodity prices, but in the context of a continuing secular downtrend in response to excess supply.

Continuing low inflation on the back of global spare capacity and weak commodity prices, notably oil.

Continuing sub-par growth in Australia of around 2.5% for most of the year in response to falling mining investment, the commodity price slump and budget cuts but with the hope of some improvement by year end.

Easy monetary conditions with the US very gradually raising rates (two hikes at best, but the risk is one or none), but on going easing in Europe, Japan, China and Australia.

A further rise in the $US but at a slower rate than seen over the last two years, with the $A falling to around $US0.60.

Solid returns from commercial property and infrastructure, but soft gains of around 3% for Australian residential property prices as Sydney and Melbourne slow.

Low returns from low yielding cash and bonds.

Key risks for 2016

The Fed could prove to be too aggressive in raising rates, and even if it isn’t the fear of this could continue to weigh.

The combination of the Fed and low oil prices causing ongoing problems for indebted US energy producers could cause more weakness in credit markets.

Political uncertainty could remain a threat in the Eurozone, particularly in relation to Spain (after its messy election) and around populist/extremist parties gaining support.

Chinese growth could disappoint with policy uncertainty around Chinese shares and the Renminbi continuing to unnerve investors.

Plunging emerging market currencies (and commodity prices) could trigger a default event somewhere in the emerging world on US dollar debt.

The loss of national income from lower commodity prices and the continuing unwind in mining investment and a loss of momentum in the housing sector could result in much weaker Australian economic growth.

Factor X – there is always something from left field. Last year it was China fears.

Five things to watch

The Fed – US inflation is likely to be key here.

The $US – a continued surge in the $US, particularly via the Chinese Renminbi, will be negative for commodities and emerging currencies raising the risk of an emerging market crisis (eg, a default on US dollar debt).

Global business conditions indicators (or PMIs) – these have been slowing for manufacturers but ok for services.

Four reasons why shares are likely to provide decent returns by year end…

A global recession is unlikely – deep and long bear markets normally require a recession (in the US at least).

Monetary conditions are very easy and likely to get easier still as while the Fed may start to tighten other central banks are still easing.

There is a lot of pessimism around.

...but three reasons to expect continued volatility

Global growth remains fragile.

The risk of an emerging market crisis remains high, particularly with China still depreciating the Renminbi versus the $US and commodity prices remaining weak.

Shares are not dirt cheap and there is a greater dependence on earnings.

Nine things investors should remember

The power of compound returns – saving regularly in growth assets can grow wealth substantially over long periods. Using the “rule of 72” it will take 29 years to double an asset’s value if it returns 2.5% pa (ie 72/2.5) but only 9 years if the asset returns 8% pa.

The cycle lives on – markets cycle up and down and we need to allow for it and not get thrown off by rough patches, like the one we are currently going through.

Diversify – don’t put all your eggs in one basket and consider active asset allocation to enhance returns/protect against falls.

Turn down the noise – the information revolution is making us more jittery and leading to worse investment decisions.

Starting point valuations matter – so buy low and sell high. Selling after major falls (like those seen recently) just locks in losses.

Remember that while share values can be volatile, the dividend or income stream from a well-diversified portfolio of shares is more stable over time (and now much higher) than the income flow from bank deposits.

Related topics

Important information

Dr Shane Oliver, Chief Economist and Head of Investment Strategy at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.